A 1997 review of countries' practices for compiling data on foreign direct
investment (FDI) transactions indicated that the treatment of three types
of FDI transactions cause confusion among compilers:

Transactions with affiliated financial intermediaries

Payments associated with the acquisition of a right to undertake
a direct investment

The shutdown of an FDI enterprise established for natural
resources exploration

The IMF subsequently examined these issues and presented a paper to the
October 1999 meeting of the IMF Committee on Balance of Payments Statistics
(the Committee), a copy of which is posted on the balance of payments
website (http://www.imf.org/external/bopage/pdf/clarif.pdf—32Kb PDF file.)
The Committee agreed with the recommendations in that paper, but asked
for further discussion with interested groups, such as the OECD's Working
Party on Financial Statistics (WFS), and the European Central Bank's Working
Group on Balance of Payments and External Reserves (WGBP&ER), prior
to making a final decision. The final decisions of the Committee are set out below.

Transactions with affiliated financial intermediaries

In the case of the transactions with affiliated financial intermediaries,
confusion has arisen for three reasons:

The text in paragraph 372 of the fifth edition of the Balance
of Payments Manual (BPM5) that limits FDI transactions "between
affiliated banks (depository corporations) and affiliated financial
intermediaries (e.g. security dealers)" to transactions involving
equity and permanent debt could be interpreted as meaning only those
transactions between affiliated banks and between affiliated
financial intermediaries, and not transactions between affiliated
banks and affiliated financial intermediaries.

BPM5 and the Balance of Payments Textbook(BOP
Textbook) are not clear about what exactly is meant by financial
intermediaries.

The text in the BOP Textbook (paragraphs 542-544) that
specifically excludes from the FDI data all non-equity/permanent
debt transactions between a nonfinancial enterprise and an affiliated
[Special Purpose Enterprise] (SPE) with the sole purpose of
financial intermediation, and specifically includes such transactions
between a nonfinancial enterprise and an affiliated SPE with the primary
purpose of financial intermediation has also caused concern because
of the argument that there is essentially no economic difference between
the two types of SPEs.

Following discussions with the OECD WFS and the ECB WGBP&ER, the
Committee at its October 2001 meeting reached the following decisions
on the recommended treatmentof transactions with affiliated financial
intermediaries.

The BPM5 definition of the scope of enterprises included
under "banks and other financial intermediaries such as security
dealers" should be clarified as being equivalent to the following
SNA93 financial corporations sub-sectors: other depository corporations
(other than the central bank); other financial intermediaries, except
insurance corporations and pension funds; and financial auxiliaries.
As a result, SPEs principally engaged in financial intermediation
for a group of related enterprises would be encompassed in that definition.

The implications of the above clarification are that
financial (and investment income) transactions between two affiliated
enterprises that are part of (1) other depository corporations
(other than the central bank); (2) other financial intermediaries,
except insurance corporations and pension funds; or (3) financial
auxiliaries would be excluded from FDI except for transactions in
the form of equity capital or permanent debt.

Financial transactions between units that are not financial
intermediaries and affiliated financial SPEs abroad should be recorded
under FDI.

It is important to note that this last recommendation overturns the practice
described in the BOP Textbook, which excludes from the FDI data
transactions between nonfinancial FDI enterprises and affiliated SPEs
with the sole purpose of financial intermediation. The effect of the recommendation
is that there will no longer be any difference in the treatment of SPEs
that have the sole purpose of financial intermediation and SPEs that have
the primary purpose of financial intermediation—the FDI data are to include
both (i) transactions between nonfinancial FDI enterprises and affiliated
SPEs with the sole purpose of financial intermediation,
and (ii) transactions between nonfinancial FDI enterprises and affiliated
SPEs with the primary purpose of financial intermediation.

The Committee also agreed that, in light of concerns expressed by some
members of the OECD and ECB groups, the decision about the inclusion in
the FDI data of financial transactions between units that are not financial
intermediaries and affiliated financial SPEs abroad would be re-examined
in the context of the next revision of the Balance of Payments Manual.
In the meantime, countries that exclude such transactions from the direct
investment data are encouraged to explain their practices and if possible
to publish memorandum items to facilitate international comparability.

Payments associated with the acquisition of a right to undertake a
direct investment

In many developing or transition economies, the government requires the
payment of a fixed amount of money by direct investors for the right to
undertake a direct investment in the host economy. Often, but not always,
these operating or concession rights are related to the extraction of
natural resources. In transition economies, compilers refer to these payments
as "bonuses". They are legal transactions and should not be
associated with poor governance. The issue was to determine whether or
not such bonuses constitute direct investment transactions and to recommend
a common recording practice for such transactions.

Following consultations with the OECD and ECB groups, the Committee decided
at its October 2001 meeting that the recommended treatment of payments
for the right to undertake a direct investment is to be as follows:

The contra-entry to the payment of a rent (bonus) by
a non-resident investor to the government authorities should be recorded
under direct investment when there is a clear intention to establish
a direct investment enterprise (such as in the case of a contractual
arrangement between the investor and the government).

The contra-entry to the payment of a rent by a non-resident
enterprise, when no direct investment enterprise is or will be established,
should be recorded under "income; investment income; other investment"
until a "rent" sub-component of income is included in the
balance of payments manual. Rent would be paid by non-resident enterprises
when they make payments to exploit movable natural resources such
as in the case of tree cutting rights or fishing rights in a country's
territorial waters.

The shutdown of an FDI enterprise established for natural resources
exploration

The recommendation in paragraph 383 of BPM5 is that "expenditures
of direct investment enterprises established for exploration of minerals
and other natural resources in an economy are treated as capital expenditures
(fixed capital formation)." In addition, the text stipulates that
"if the exploration proves unsuccessful and results in a shutdown
of the enterprise, no further balance of payments entries are recorded.
Rather, a negative stock adjustment is made in the direct investment position
of the direct investor in the host economy, and an equal reduction is
made in the liability position of that economy to that of the direct investor.
(Both adjustments fall under the heading other adjustments in the international
investment position.)" Paragraph 60 of the OECD Benchmark Definition
of Foreign Direct Investment (Benchmark) uses similar language.

However, some balance of payments compilers have argued that a stream
of negative reinvested earnings flows should be recorded in the current
account of the host economy over a number of years until the stock of
fixed capital corresponding to the total exploration expenditures of the
direct investment enterprise has been fully amortised as consumption of
fixed capital, with corresponding entries recorded for the investing economy.
Such treatment would be consistent with the System of National Accounts
1993 (SNA93), paragraph 10.91 of which recommends that the
capitalized exploration costs should be amortized as consumption of fixed
capital over the average service lives of such exploration assets. According
to that argument, the direct investment enterprise continues to exist
and the equity value remains until it is fully amortized. Each year, the
direct investment enterprise will have negative reinvested earnings equivalent
to the amortization of the exploration asset. If the amortization approach
is not adopted, there is an asymmetric treatment of unsuccessful expenditures
in natural resources exploration in the host economy's national balance
sheets, as such expenditures of "national" enterprises would
be amortized whereas those of direct investment enterprises would be written-off.

The paper presented to the Committee in 1999 argued that there were three
possible approaches to treating the shutdown of an FDI enterprise established
for natural resources exploration:

The first approach would be the amortization method envisaged
above. However, this is an unsatisfactory approach in a balance of payments
context, as following the shut-down of the enterprise the direct investor
does not have a claim on the host economy and, symmetrically, the host
economy does not have a liability to the investor. Thus, the flows of
reinvested earnings that are recorded are purely artificial and cannot
be associated with any nonresident claims or liabilities.

A second approach, which would also satisfy the requirements
of the SNA93, would be to record a capital transfer, by the
direct investor to the host economy, that corresponds to the residual
value of the natural resources exploration costs, which would be the
contra-entry for the equity capital withdrawal by the direct investor
that follows the shutdown of the operation and would correspond to
a transfer of know-how to the host economy equal to the value of the
exploration expenditure not yet depreciated under consumption of fixed
capital. However, this is not the preferred approach as the direct
investor did not willingly transfer the know-how concerning
the location of dry holes, in the instances of oil exploration, but
was simply faced with non-profitable operations and forced to write-off
these expenditures.

The third approach, which is the one set out in BPM5
and the Benchmark, is to use the other adjustments heading
of the International Investment Position (IIP) statement, even though
this approach creates an asymmetry in the treatment of the natural
resources exploration expenditures that cannot be resolved under the
framework of the SNA93.

In light of the concurrence of the OECD and ECB groups, the Committee
decided that the recommended treatment in instances of the shutdown of
an FDI enterprise established for natural resources exploration is that
the transactions should be recorded in accordance with the approach set
out in BPM5 and the Benchmark, namely, to use the other adjustments heading
of the IIP statement to show the reduction in assets, and to show no further
entries in the balance of payments statistics.